Scenario 1: You are an active investor & owner of a specific private company and get to make decisions: company makes $X in profit. You get to decide whether to take part of $X back (i.e. take the dividend), or leave it all on the company books and reinvest in some projects (e.g. expand into new markets or come up with new products, etc), or buy back some shares (similar to dividend, but could be more tax efficient). Your decision may depend on kinds of reinvestment projects the company can do and your tax implications.

Scenario 2: You are an investor in some company but don't get to make decisions about dividend policy. You do however know the company in and out and you can decide whether dividend policy they have from Scenario 1 is something you agree with. If you strongly agree with it, you may buy more shares. If you strongly disagree with it, you sell your shares and go somewhere else. If enough investors agree with you, this would mean dividend policy affected the share price.

Scenario 3: You invest in a fund which consists of many companies. You believe other people from above 2 scenarios correctly price dividend policies into the share prices (or close enough), and these dividends don't affect your taxes enough to worry either (e.g. you own this fund in tax-advantaged account). In this case, you don't care about dividends much.

Scenario 4: You invest in a fund which consists of many companies but you believe overall market does not give enough value to dividends (e.g. because history shows dividend-paying stocks outperform rest of market). Then you get to decide whether to invest in funds that agree with your vision (e.g. tilt toward investing in dividend payers). These are normally active funds with some extra fee.

Scenario 5: You invest in a fund which consists of many companies but you believe overall market gives too much value to dividends for your situation (e.g. because your investment is in taxable account). Then you get to decide whether to invest in funds that agree with your vision (e.g. tax-managed funds). These are normally active funds with some extra fee.

GuitarXM wrote:Price changes for various reasons but the market is mostly efficient. People aren't that stupid. They know that a dividend is about to be paid out so they increase the price of the stock by the dividend amount. So you didn't lose anything. You got a dividend and the stock price ultimately remained the same. The value of the company drops by the dividend amount cause the company lost that money and gave it to the shareholders. The shareholders expect the dividend in the future so the stock price rises to what it was before. This is a simplified version that doesn't take account of value of the company which is what really drives the price.

We agree that the dividend itself provides no value, right? That your net worth before and after the dividend is the same? Then why should people clamor to buy a stock in anticipation of a dividend that gets them nothing? This does not sound rational to me.

rbaldini wrote:
We agree that the dividend itself provides no value, right? That your net worth before and after the dividend is the same? Then why should people clamor to buy a stock in anticipation of a dividend that gets them nothing? This does not sound rational to me.

If a company has profits and can't see a good way to use them to grow its business, what do you propose the company do with the money?

GuitarXM wrote:Price changes for various reasons but the market is mostly efficient. People aren't that stupid. They know that a dividend is about to be paid out so they increase the price of the stock by the dividend amount. So you didn't lose anything. You got a dividend and the stock price ultimately remained the same. The value of the company drops by the dividend amount cause the company lost that money and gave it to the shareholders. The shareholders expect the dividend in the future so the stock price rises to what it was before. This is a simplified version that doesn't take account of value of the company which is what really drives the price.

We agree that the dividend itself provides no value, right? That your net worth before and after the dividend is the same? Then why should people clamor to buy a stock in anticipation of a dividend that gets them nothing? This does not sound rational to me.

GuitarXM wrote:Price changes for various reasons but the market is mostly efficient. People aren't that stupid. They know that a dividend is about to be paid out so they increase the price of the stock by the dividend amount. So you didn't lose anything. You got a dividend and the stock price ultimately remained the same. The value of the company drops by the dividend amount cause the company lost that money and gave it to the shareholders. The shareholders expect the dividend in the future so the stock price rises to what it was before. This is a simplified version that doesn't take account of value of the company which is what really drives the price.

We agree that the dividend itself provides no value, right? That your net worth before and after the dividend is the same? Then why should people clamor to buy a stock in anticipation of a dividend that gets them nothing? This does not sound rational to me.

Say that a company works this way:
It accumulates x dollars profit per day in an internal bank account
It distributes that profit quarterly to its owners(shareholders)

Prior to the distribution, as an owner you "own' a share of the money in the account. As it builds up prior to the dividend being paid, all things being equal your share of the company is worth more as you have a claim on part of the money. After the dividend, the value of your shares decreases by the amount paid out to you. Obviously other things are affecting share price, but in terms of dividends I think this is roughly what is happening. How would you expect this to be different?

I think there have been some good points made in this thread about when it's better for a company to pay out dividends. Though from a tax perspective, why it couldn't just be 100% share buybacks? I'm not sure I fully understand the effects of share buybacks.

Look at the performance of Berkshire Hathaway stock. I believe most if not all of their holdings pay dividends. Seems odd that a holding company can manage all those different shares that pay dividends, never pay any dividends to shareholders, yet a tax managed index fund can't do the same thing.

Also, reading on this forum, I've seen it mentioned that more and more companies are opting to not pay dividends and share buybacks are increasing. I've thought to myself: Could share buybacks become such a huge thing in the future that these dividend funds (some which I really do like the looks of) rename themselves to share buyback funds?
Of course if share buybacks become that big, I imagine the tax code could easily change to treat them as dividends are treated now...

Da5id wrote:
As it builds up prior to the dividend being paid, all things being equal your share of the company is worth more as you have a claim on part of the money. After the dividend, the value of your shares decreases by the amount paid out to you.

Why does price build up prior to the dividend being paid? That is my question.

If the answer is "because people like getting the dividend", then my question is "why?" When you receive the dividend, the value of your holdings drops the same amount, so you have actually gotten nothing. So that doesn't seem like a good answer.

Again, I'm not sure if there is some difference in how dividends work between stocks and stock funds. I only invest in funds, and have noticed that whenever I am "given" a dividend, I am no richer than the day before.

Da5id wrote:
As it builds up prior to the dividend being paid, all things being equal your share of the company is worth more as you have a claim on part of the money. After the dividend, the value of your shares decreases by the amount paid out to you.

Why does price build up prior to the dividend being paid? That is my question.

If the answer is "because people like getting the dividend", then my question is "why?" When you receive the dividend, the value of your holdings drops the same amount, so you have actually gotten nothing. So that doesn't seem like a good answer.

Again, I'm not sure if there is some difference in how dividends work between stocks and stock funds. I only invest in funds, and have noticed that whenever I am "given" a dividend, I am no richer than the day before.

Mutual funds pay out distributions because they are required to by law. Mutual funds are not stocks. Does that answer your question?

Or are you still wondering about companies? Or did you not understand my example? I'm really baffled at this point.

Da5id wrote:
Mutual funds pay out distributions because they are required to by law. Mutual funds are not stocks. Does that answer your question?

Or are you still wondering about companies? Or did you not understand my example? I'm really baffled at this point.

My original question was "why should I care about dividends?" Perhaps I should have been more specific and said "Given that I invest in stock mutual funds, why should I care about dividends?" People seem to like buying funds that yield dividends. My point is that I do not understand why they do, given that a stock fund's dividend gives me nothing. I was trying to see if I was wrong about this. I'm still not sure.

rbaldini wrote:
My original question was "why should I care about dividends?" Perhaps I should have been more specific and said "Given that I invest in stock mutual funds, why should I care about dividends?" People seem to like buying funds that yield dividends. My point is that I do not understand why they do, given that a stock fund's dividend gives me nothing. I was trying to see if I was wrong about this. I'm still not sure.

A lot of stocks pay dividends. If you are buying anything like the market, you will get dividends. There is not much choice involved. I believe as a investor you shouldn't generally care about dividends per se, you should care about total return. But I don't think avoiding dividends is a practical option.

Day 1 stock price $10.
Day 2 stock pays out $1 Dividend, Price of stock drops to $9.
You keep the dividend. At this point in time nothing changes. Net worth is same.
Day 3, Day 4, Day 5.....etc until next dividend date.
Stock starts going up before dividend. The stock is now $10.
Again. $1 dividend, stock price is $9...

What do you now have? $2 in dividends and stock price is $9?
So now your worth is $11

Imagine you are buying this stock right before the dividend date. Why would you buy it when you know its going to go down?
You wont buy it unless the stock price is higher. When the stock price goes up and the dividend will decrease it back down to where it was you will have the same net worth. So this is what happens. People bid the price up.

rbaldini wrote:
My original question was "why should I care about dividends?" Perhaps I should have been more specific and said "Given that I invest in stock mutual funds, why should I care about dividends?" People seem to like buying funds that yield dividends. My point is that I do not understand why they do, given that a stock fund's dividend gives me nothing. I was trying to see if I was wrong about this. I'm still not sure.

A lot of stocks pay dividends. If you are buying anything like the market, you will get dividends. There is not much choice involved. I believe as a investor you shouldn't generally care about dividends per se, you should care about total return. But I don't think avoiding dividends is a practical option.

To belabor the obvious and simplify, which apparently is necessary in this thread:
There are tax managed funds that strive to avoid taxable events like dividends and capital gains for those who want to minimize current taxes.
There are also dividend funds that pay relatively high dividends for those who want current income.
Fast growing companies often offer minimal or no dividends but greater capital gains, realized or not.
Stable mature and slower growing companies often offer higher dividends but lower or no capital gains.
Total return is the most critical criterion for most investors, especially in tax-favored accounts.

Day 1 stock price $10.
Day 2 stock pays out $1 Dividend, Price of stock drops to $9.
You keep the dividend. At this point in time nothing changes. Net worth is same.
Day 3, Day 4, Day 5.....etc until next dividend date.
Stock starts going up before dividend. The stock is now $10.
Again. $1 dividend, stock price is $9...

What do you now have? $2 in dividends and stock price is $9?
So now your worth is $11

Imagine you are buying this stock right before the dividend date. Why would you buy it when you know its going to go down?
You wont buy it unless the stock price is higher. When the stock price goes up and the dividend will decrease it back down to where it was you will have the same net worth. So this is what happens. People bid the price up.

I get the math. You are saying that the price rises up to $10 again between the dividends. This is where your money is made: the dividend itself gives you nothing. Let's be even more explicit:

Day 1: You invest $100 in stock that is $10/share. So, you have a total of $100 invested in 10 shares.
Day 2: Dividend paid. You are given $1/share (so $10), so the share price is now $9. You have $10 + $9*10 = $100. You reinvest the dividend, giving you $100 spread across 11.11111 shares. Still $100: no effect.
(Many days pass until the day before the next dividend. Call it Day N)
Day N: The stock price has risen back to $10. You have $111.11. You have profited due to price increase: yay!
Day N+1: Dividend paid. You are given $1/share again (so $1*11.11 = $11.11), but share price has now dropped to $9 again. So you have $11.11 + $9*11.111 = $111.11. Exactly the same amount as yesterday, before the dividend was paid. Again, no effect.
(And so on forever)

*All of your money was made between the dividends*, due to price increase. The dividend itself was irrelevant. Now, if I understand you correctly, then part of the reason the stock price rose in the interim was because people wanted to get the dividend. But this is silly, since I've just shown that the dividend gives you nothing.

Last edited by rbaldini on Wed Nov 02, 2016 11:56 am, edited 2 times in total.

OP: its psychological. If you have no problem periodically selling shares after you retire, you can ignore dividends. If you, like myself and many others, have a mental block against selling shares due to a fear of selling at a low price (and a lifelong compulsion to hoard wealth), funds which issue dividends are a way to enforce withdrawal to spend and enjoy.

The idea that dividends help to keep management honest sounds logical but has no basis in reality. CEOs of dividend paying companies will still get their cushy compensation and fringe benefits. I have never heard of management getting pay docked when a company had a bad quarter so the company can make th dividend payment.

I once invested in an oil tanker company with a minimal number of employees that promised to pay out all earnings as dividends. Sounded good until the management kept compensating themselves with more shares and also periodically put on secondary share offers which knocked share price down. That was a hard lesson I learned, i,e. Don't put too much stock in the presence of dividends.

As many have stated, dividends are useful when the management can't find truly good opportunities. Apple made the right choice to return part of quarterly cash flow back to shareholders as dividends instead of spending on wild goose chase projects like Google once did. Microsoft made the same call some years back.

Everything else being equal, if the dividend wasn't paid people wouldn't bid the stock price up and you wouldn't get money through price appreciation.

Also remember that dividends tell you how healthy the company is.
If the company reduces a dividend, the stock price will fall big time because that signals to the market that they cant make that payment, that something is wrong. Now it could be that they decide not to pay the dividend because they want to reinvest it into something that will make you more money in the future by increasing earnings; the market doesn't see it that way.

GuitarXM wrote:Everything else being equal, if the dividend wasn't paid people wouldn't bid the stock price up and you wouldn't get money through price appreciation.

So you are claiming that, indeed, it is the dividend that causes stock price to rise in general. I'm saying I don't understand why.

GuitarXM wrote:
If the company reduces a dividend, the stock price will fall big time because that signals to the market that they cant make that payment

What payment? I have never received wealth during a dividend payment: my wealth is always the same as the day before. Is this the distinction between a single stock and a mutual fund that holds stocks? (I only own the latter.)

rbaldini wrote:
Why does price build up prior to the dividend being paid? That is my question.

The mutual fund price or Net Asset Value represents the net worth of the fund which includes the value of all shares of held stocks plus the cash dividends received from the shares held by the fund less fund expenses. The cash for the dividend distribution does not appear out of thin air at distribution time, they are received from the underlying holdings throughout the year or quarter and accumulate.

bamn wrote:Given that dividends are the mechanism by which companies give their owners the profits, I also find it odd to think about a world without dividends. What would be the point of owning a company if it was sure to never pay you? Could you even count on capital appreciation of the shares, since there'd be no basis for speculation?

I'm taking the investor's perspective. Why should I, an investor, care about receiving dividends, when they do not increase my wealth but do increase my tax burden? Am I missing something?

Stock is ownership in a company. Dividends are a distribution of profits from the company to owners (stock holders).
If a company is not growing and re-investing its profits to grow it pays dividends. New young companies rarely pay dividends because profits are poured into growing the company. Older more stable companies tend to pay dividends since they may not be in growth mode anymore.

DSInvestor wrote:
The mutual fund price or Net Asset Value represents the net worth of the fund which includes the value of all shares of held stocks plus the cash dividends received from the shares held by the fund less fund expenses. The cash for the dividend distribution does not appear out of thin air at distribution time, they are received from the underlying holdings throughout the year or quarter and accumulate.

I think I'm close to understanding this, but not quite there yet. You're saying the the price of a mutual fund rises in part because it receives cash dividends from the stocks it holds, yes? If I understand the concept of price correctly, then to say "the fund price rises" implies that people are more willing to buy fund shares / less willing to sell fund shares as it accumulates this cash, so supply+demand causes price to rise. I'm struggling to understand why this is the case. Say I have shares in a fund with some initial NAV. Then suppose that fund accumulates a whole lot of cash dividend from its stocks. Why should I care about that? Yes, the fund will "distribute" the gain to me - but I don't actually gain anything when this happens, since the fund's value is reduced by the amount they distribute. So why should I value fund shares more highly after it has acquired a bunch of cash? Surely I'm missing something fundamental here.

DSInvestor wrote:
The mutual fund price or Net Asset Value represents the net worth of the fund which includes the value of all shares of held stocks plus the cash dividends received from the shares held by the fund less fund expenses. The cash for the dividend distribution does not appear out of thin air at distribution time, they are received from the underlying holdings throughout the year or quarter and accumulate.

I think I'm close to understanding this, but not quite there yet. You're saying the the price of a mutual fund rises in part because it receives cash dividends from the stocks it holds, yes? If I understand the concept of price correctly, then to say "the fund price rises" implies that people are more willing to buy fund shares / less willing to sell fund shares as it accumulates this cash, so supply+demand causes price to rise. I'm struggling to understand why this is the case. Say I have shares in a fund with some initial NAV. Then suppose that fund accumulates a whole lot of cash dividend from its stocks. Why should I care about that? Yes, the fund will "distribute" the gain to me - but I don't actually gain anything when this happens, since the fund's value is reduced by the amount they distribute. So why should I value fund shares more highly after it has acquired a bunch of cash? Surely I'm missing something fundamental here.

I think you just need to ponder it. But one more try:

You own a piggy bank worth $5. You put 25 cents into it. What is the piggy bank worth, and why? I think it really is that simple...

HomerJ wrote:
The OP asked why the dividend is considered a "certain" return. Stock prices move up and down. You have no idea what the stock price will be in a year, but one component is much more "certain". If nothing else, you'll make 2% off that stock this year. (Yes, dividends can be cut... so nothing is 100% "certain")

And no I don't automatically re-invest dividends. I send them to a MM account, and then use them to rebalance at the end of the year. And when I retire, I'll use them as income.

No matter how much the stock price gyrates one can withdraw exactly whatever amount of money one wants by selling enough shares to do that. This only fails if the total value of the investment has fallen below the amount wanted. In that case dividends will not supply that withdrawal either. At least it would be unusual for the dividend yield to exceed 100%, pehaps only one last time as a company failes.

PS The statement that one will "make" the dividend off the stock that year is a misunderstanding. What one makes is the return, which is the combination of price changes and dividend payout (in the case of fund, also distributions). That return is not made more certain by part of it being paid in dividends unless one finds that some selections of investments sorted on dividend yield are less risky at the same return as some other investments that have less or no dividend yield, all other factors being the same.

DSInvestor wrote:
The mutual fund price or Net Asset Value represents the net worth of the fund which includes the value of all shares of held stocks plus the cash dividends received from the shares held by the fund less fund expenses. The cash for the dividend distribution does not appear out of thin air at distribution time, they are received from the underlying holdings throughout the year or quarter and accumulate.

I think I'm close to understanding this, but not quite there yet. You're saying the the price of a mutual fund rises in part because it receives cash dividends from the stocks it holds, yes? If I understand the concept of price correctly, then to say "the fund price rises" implies that people are more willing to buy fund shares / less willing to sell fund shares as it accumulates this cash, so supply+demand causes price to rise. I'm struggling to understand why this is the case. Say I have shares in a fund with some initial NAV. Then suppose that fund accumulates a whole lot of cash dividend from its stocks. Why should I care about that? Yes, the fund will "distribute" the gain to me - but I don't actually gain anything when this happens, since the fund's value is reduced by the amount they distribute. So why should I value fund shares more highly after it has acquired a bunch of cash? Surely I'm missing something fundamental here.

There's nothing to understand. In the way you are asking, no, dividends don't do anything (from a mathematical, accounting, first-level perspective) to add returns in some special way. A fund is just a container for the individual stocks and doesn't change what's going on with respect to wealth not being created from shifting cash around. It's just that many people have issues interpreting a question and responding properly to a way of thinking that doesn't align with their worldview. myself included

That is not an attack on dividends and here not even a critique of dividend investing. Objectively dividend stocks have on average different properties than non-dividend stocks, and there are differences when sorting stocks by dividend yield or some other measure, like for anything else.

The impact of dividends is in taxation, the well-covered issue by now of what companies should do with excess cash and the rate of return on reinvestment and so on (though buybacks work much the same), and then "soft" considerations regarding signaling and investor expectations.

GuitarXM wrote:Everything else being equal, if the dividend wasn't paid people wouldn't bid the stock price up and you wouldn't get money through price appreciation.

So you are claiming that, indeed, it is the dividend that causes stock price to rise in general. I'm saying I don't understand why.

GuitarXM wrote:
If the company reduces a dividend, the stock price will fall big time because that signals to the market that they cant make that payment

What payment? I have never received wealth during a dividend payment: my wealth is always the same as the day before. Is this the distinction between a single stock and a mutual fund that holds stocks? (I only own the latter.)

It doesn't matter whether its a mutal fund or an individual stock. The concept remains the same.
No. Stock prices in GENERAL don't rise because of the dividend. People aren't buying and selling stock for the dividend. They buy and sell because they think the value of the stock will increase or decrease in the future.

But what I'm saying is that if you take that value analysis out and pretend it didn't exist then YES the dividend payout is exactly what causes the price of the stock to go up right before the dividend date.

Imagine if the stock price didn't go down. Then you can just buy the stock right before the dividend date, pocket the dividend and sell right away and keep doing that to all stocks. It doesn't work that way. Not to mention that you have to own the stock for 60 consecutive days within 120 day period around the ex-dividend date to get the preferred tax payment on the dividend as defined by the IRS. I think it ranges for something like 5 to 15%. Not sure.

So to be fair, the stock exchange reduces the stock price by the dividend amount because the people who bought the stock before the ex-dividend date are paying a higher price for the stock due to the anticipation of the dividend. They are paying essentially a higher price than a company is worth. Its like an equilibrium of the market. So imagine for a $1 dividend if the market is valuing the stock at $10 its going to trade at $11 before and $10 after the dividend. This way the value of the stock doesn't change and you hold your $1 dividend. This way it will go down by the dividend amount and still be worth the same price. That price increase in the stock is where you get your profit.

If the company didn't pay a dividend and reinvested all the money then you will still get a return from the stock price increase but its not a certain return. Some companies will give you a higher earnings other a lower, but when you get a dividend, its certain that your getting that amount of money. You can then do whatever you want with it. Spend it, reinvest into the same stock, etc...

bamn wrote:Given that dividends are the mechanism by which companies give their owners the profits, I also find it odd to think about a world without dividends. What would be the point of owning a company if it was sure to never pay you? Could you even count on capital appreciation of the shares, since there'd be no basis for speculation?

I'm taking the investor's perspective. Why should I, an investor, care about receiving dividends, when they do not increase my wealth but do increase my tax burden? Am I missing something?

Some stocks (XIN for example) have extremely low prices relative to their value. XIN has always had a single digit PE and the stock never budged because people thought it was another Chinese fraud. When the company started giving out dividends the value went up. Dividends only have no value in a perfectly rational market - that does not exist in practice.

Dottie57 wrote:Profits from a business owned by stockholders generally goes one of two places. 1) used by the busines to grow. 2) dividends to stockholders who own the company.

Where else do you think the profits should go?

Bonus to employees. This is not farfetched as many companies have profit sharing or "success sharing" programs. It is also not inappropriate for companies to benefit public service and charitable organizations.

Dottie57 wrote:Profits from a business owned by stockholders generally goes one of two places. 1) used by the busines to grow. 2) dividends to stockholders who own the company.

Where else do you think the profits should go?

Bonus to employees. This is not farfetched as many companies have profit sharing or "success sharing" programs. It is also not inappropriate for companies to benefit public service and charitable organizations.

Bonuses to employees are not profits but are the cost to keep your employees. Bonuses are compensation - at least that is what my megacorp employer says. . Similar for charitable activities and donations which create a good buzz about the company. Cost of doing business.

We've all heard time and time again about the "magic" of compounding that comes from re-investing dividends. Without dividends, the only gain from stocks is capital appreciation in share price. So the only way to re-invest would be to sell shares first, which makes no sense whatsoever.

But reinvesting a dividend in the same security which issued the dividend is exactly the same as if it hadn't distributed it at all...

We've all heard time and time again about the "magic" of compounding that comes from re-investing dividends. Without dividends, the only gain from stocks is capital appreciation in share price. So the only way to re-invest would be to sell shares first, which makes no sense whatsoever.

But reinvesting a dividend in the same security which issued the dividend is exactly the same as if it hadn't distributed it at all...

Not quite. You end up with more shares than you had before reinvesting the dividend.

It’s taken me a lot of years, but I’ve come around to this: If you’re dumb, surround yourself with smart people. And if you’re smart, surround yourself with smart people who disagree with you.

We've all heard time and time again about the "magic" of compounding that comes from re-investing dividends. Without dividends, the only gain from stocks is capital appreciation in share price. So the only way to re-invest would be to sell shares first, which makes no sense whatsoever.

But reinvesting a dividend in the same security which issued the dividend is exactly the same as if it hadn't distributed it at all...

Not quite. You end up with more shares than you had before reinvesting the dividend.

More shares at a lower price - same value. So yes, not 'exactly the same' just functionally exactly the same.

The company is earning money over time, assuming it's profitable. It's your part-ownership of this earned money that causes the stock price to increase between dividend payments; and then the money is paid out and you actually have your share of the money that you part-owned. From a long-term investor's standpoint, there is no net difference between any of the following:

Dividend payout - returning the money evenly to all shareholders

Reinvestment in further infrastructure/growth - increasing the value of the underlying assets and the anticipated future revenue

Share buyback - returning the money to some shareholders, making the shares held by the others more valuable

Accumulated capital against future needs - maintaining the value in underlying assets and reducing the impact of future events on future revenue

The real difference is whether any of the non-payout options is actually beneficial, which will be a situational decision by the company. A restaurant using the money to build new locations with (hopefully) new revenue in the future will cause the share value to continue growing, since the company and its assets continue to grow more valuable. Or a company investing in R&D to develop new future products. But a company that has saturated its market can't produce a worthwhile return on further investment, or may have more cash flow than it can currently invest to good return. In those situations, either dividends or buybacks are the best use of the money.

And as noted, there are psychological reasons why some investors like to have a steady payout and never sell their shares. That leads some companies to favor dividend payouts versus stock buybacks. Other companies go the other direction.

You'll note, too, that the mutual fund works in precisely the same way. The shares that it owns pay out dividends, which the fund accumulates and you have part-ownership of those accumulated funds. Quarterly, the fund pays out all the accumulated dividends and drops in price by the same amount.

avalpert wrote:
More shares at a lower price - same value. So yes, not 'exactly the same' just functionally exactly the same.

You have bought someone else's shares with the dividend (rather than pocketing it or using it for some other purpose). You now own a higher percentage of the company and accordingly more of its future earnings. If the dividend payout per share remains the same, you will get more money next quarter. The person who sold you the shares will get none. How is that functionally equivalent?

We've all heard time and time again about the "magic" of compounding that comes from re-investing dividends. Without dividends, the only gain from stocks is capital appreciation in share price. So the only way to re-invest would be to sell shares first, which makes no sense whatsoever.

But reinvesting a dividend in the same security which issued the dividend is exactly the same as if it hadn't distributed it at all...

Not quite. You end up with more shares than you had before reinvesting the dividend.

More shares at a lower price - same value. So yes, not 'exactly the same' just functionally exactly the same.

It seems to me that there is an inappropriate concentration of attention on the moment of distribution versus the long-term impact. Yes, admittedly and without contention, the net dollar-value effect of a distribution of dividends at the time of distribution is essentially zero. However, if one can get past that and look down the road, then one should realize that more shares of a particular security will long-term result in more dividends, more total dollar value, and more return overall than fewer shares would. So if one can accumulate more shares of a security with (admittedly) no additional dollar cost, then why is dividend reinvestment a bad thing?

It’s taken me a lot of years, but I’ve come around to this: If you’re dumb, surround yourself with smart people. And if you’re smart, surround yourself with smart people who disagree with you.

avalpert wrote:
More shares at a lower price - same value. So yes, not 'exactly the same' just functionally exactly the same.

You have bought someone else's shares with the dividend (rather than pocketing it or using it for some other purpose). You now own a higher percentage of the company and accordingly more of its future earnings. If the dividend payout per share remains the same, you will get more money next quarter. The person who sold you the shares will get none. How is that functionally equivalent?

You own a higher percentage of a company worth less than it was before - unless this marginal increase in ownership gives you majority control it is functionally the same.

Let's illustrate it with simple numbers.

Case 1: I own 10 shares in a company worth $11/share that gives $1/share dividend which I reinvest. I now own 11 shares in a company worth $10/share. The company value grows over the next quarter 10% back to the $11/share, I have $121 in value. They distribute their $1/share dividend and I now get $11 in dividends and am left with 11 shares worth $10/share - for a total value of $121.

Case 2: I own 10 shares in a company worth $11/share that doesn't distribute a dividend. The company value grows over the next quarter 10% to now be worth $12.10. I own 10 shares in that company, or $121 of value.

See, reinvesting dividends is functionally the same as if they didn't distribute dividends at all.

We've all heard time and time again about the "magic" of compounding that comes from re-investing dividends. Without dividends, the only gain from stocks is capital appreciation in share price. So the only way to re-invest would be to sell shares first, which makes no sense whatsoever.

But reinvesting a dividend in the same security which issued the dividend is exactly the same as if it hadn't distributed it at all...

Not quite. You end up with more shares than you had before reinvesting the dividend.

More shares at a lower price - same value. So yes, not 'exactly the same' just functionally exactly the same.

It seems to me that there is an inappropriate concentration of attention on the moment of distribution versus the long-term impact. Yes, admittedly and without contention, the net dollar-value effect of a distribution of dividends at the time of distribution is essentially zero. However, if one can get past that and look down the road, then one should realize that more shares of a particular security will long-term result in more dividends, more total dollar value, and more return overall than fewer shares would. So if one can accumulate more shares of a security with (admittedly) no additional dollar cost, then why is dividend reinvestment a bad thing?

See my response above - this is just not true. You can't make value out of simply handing out dividends and taking them back.

By the way, no one said (at least here in this context) that dividend reinvestment is a bad thing in and of itself, just that it is no different than not distributing the dividends in the first place. Personally, I can kind of understand people chasing dividends for income because they have an aversion to selling, but people who seek out dividends for the sake of reinvesting them in the same security make no sense to me at all. I reinvest dividends in certain funds (particularly in my 401k) but I would just as soon the dividends not have materialized in the first place.

avalpert wrote:
See, reinvesting dividends is functionally the same as if they didn't distribute dividends at all.

If they didn't distribute dividends, where is your theory of where the money would go? Seems like a company has a few choices for net profits:

1) reinvest them in the business, if there are good opportunities to do so (may not be the case if company is mature)
2) give money back to shareholders (owners) as dividends/share buybacks
3) ???

Assuming option 1 isn't appropriate, what do you propose the company do?

Assuming they don't have good use for the dollars - I'd advise number 2 is the right thing to do (and for what it is worth, I did have that very discussion, as a consultant, with Microsoft Treasurer Brent Callinicos in 2002 and like to think I had some role in guiding their decision to start offering dividends).

But let me ask you, as an investor, when a company says it doesn't have any investment opportunities to use this capital that will return more than the average cost of capital (whatever they are using for that) - why would you want to reinvest it with them? They are telling you they can't beat the market, here make better use of this money than we can.

avalpert wrote:
Assuming they don't have good use for the dollars - I'd advise number 2 is the right thing to do (and for what it is worth, I did have that very discussion, as a consultant, with Microsoft Treasurer Brent Callinicos in 2002 and like to think I had some role in guiding their decision to start offering dividends).

But let me ask you, as an investor, when a company says it doesn't have any investment opportunities to use this capital that will return more than the average cost of capital (whatever they are using for that) - why would you want to reinvest it with them? They are telling you they can't beat the market, here make better use of this money than we can.

I don't invest in individual companies, so I don't evaluate that on a company by company basis. You appear to be suggesting that dividend paying companies are inferior to those that do not pay dividends, and and that seems not to be the case...

avalpert wrote:
Assuming they don't have good use for the dollars - I'd advise number 2 is the right thing to do (and for what it is worth, I did have that very discussion, as a consultant, with Microsoft Treasurer Brent Callinicos in 2002 and like to think I had some role in guiding their decision to start offering dividends).

But let me ask you, as an investor, when a company says it doesn't have any investment opportunities to use this capital that will return more than the average cost of capital (whatever they are using for that) - why would you want to reinvest it with them? They are telling you they can't beat the market, here make better use of this money than we can.

I don't invest in individual companies, so I don't evaluate that on a company by company basis. You appear to be suggesting that dividend paying companies are inferior to those that do not pay dividends, and and that seems not to be the case...

I am suggesting that dividend paying companies have lower future growth expectations than those that do not - and that most certainly is the case. I don't think that is even controversial.

Now, depending on your view of the value premium we can discuss what that ought to mean for future expected returns and associated 'mispricing'.

avalpert wrote:
I am suggesting that dividend paying companies have lower future growth expectations than those that do not - and that most certainly is the case. I don't think that is even controversial.

Now, depending on your view of the value premium we can discuss what that ought to mean for future expected returns and associated 'mispricing'.

I believe what you say is mostly true, but not relevant. As I understand it, dividends per se are not an independent "factor". Or are you personally investing in a basket of "no dividend" stocks because of the superior risk adjusted total return I think you are implying exists?

avalpert wrote:
I am suggesting that dividend paying companies have lower future growth expectations than those that do not - and that most certainly is the case. I don't think that is even controversial.

Now, depending on your view of the value premium we can discuss what that ought to mean for future expected returns and associated 'mispricing'.

I believe what you say is mostly true, but not relevant. As I understand it, dividends per se are not an independent "factor". Or are you personally investing in a basket of "no dividend" stocks because of the superior risk adjusted total return I think you are implying exists?

Not relevant to what? It is relevant to understanding why companies issue dividends and what it ought to be signalling about the company - which is the topic of discussion here.

It also help explain why dividend offering companies correlate to companies with lower valuations (value companies) - dividends are not as good an indicator of the factor as the valuation ratios themselves, at least according to current research, but it is an indicator and people do you use dividend funds to capture the value premium in some corners of the market.

And none of what I said implies that companies which do not offer dividend have superior risk-adjusted returns, that is a complete non-sequitur. What I implied is that companies which offer dividends have lower expected growth - as evidenced by their lower valuations. Depending on your belief in the efficiency of market pricing, you either think the market prices that expectation correctly or you think it doesn't (and maybe you think you have unique insight into the mispricing in a way that is exploitable) - but that isn't what we were talking about here.

First, dividends don't decide if you're investment will be successful or not. This only subject to long-term profit-growth, which determines both long-term capital gains and dividend increases. If any, dividends mislead investors in assuming that high dividend yields are always a good thing, which is not true.

Second, dividends are convenient to provide you with cash-flow. Especially if needed.

Third, dividends are zero-sum situation if the company can afford dividend. The are detrimental to the company, if it cannot afford them but cuts investments - or more often - makes additional debts to pay dividends. In the long-run this is detrimental to investor's performance, too.

Conclusion: Invest in companies with long-term profit-growth. If they pay dividends or not is a matter of preferences.

I'm not used to thinking about this, but isn't the framework of this discussion inhibiting a resolution?

Mathematically, dividends make no difference IN THEORY, before taxes. After taxes, yeah, some difference. Segue to Total Return discussion, as per many comments above. You should not care how much of that is via dividend vs buyback vs share return.

From the perspective of risk & control - a dividend means return of capital that is in your control, not controlled by the company. This is an important consideration. It can be valuable to have control of that money. Also, might some people get a psychological feeling of comfort from that stream of dividends, and is there value in that feeling?

From the perspective of the Individual and their personal situation, dividends may be valuable. The usual example is cash flow - dividend earning stocks can be a simple way to generate cash flow. Might not be optimal, but it can be. Ease and simplicity of access.

Da5id wrote:
Mutual funds pay out distributions because they are required to by law. Mutual funds are not stocks. Does that answer your question?

Or are you still wondering about companies? Or did you not understand my example? I'm really baffled at this point.

My original question was "why should I care about dividends?" Perhaps I should have been more specific and said "Given that I invest in stock mutual funds, why should I care about dividends?" People seem to like buying funds that yield dividends. My point is that I do not understand why they do, given that a stock fund's dividend gives me nothing. I was trying to see if I was wrong about this. I'm still not sure.

You should not care about dividends. The premise of your question is wrong.

So why do other people care about dividends, you ask?

Because most common people don't understand dividends. They think dividends are magical free money.

Ironically, dividends are bad for investors because they create a forced taxable event. It's basically as if the company forced you to sell some stock.

It seems to me that there is an inappropriate concentration of attention on the moment of distribution versus the long-term impact. Yes, admittedly and without contention, the net dollar-value effect of a distribution of dividends at the time of distribution is essentially zero. However, if one can get past that and look down the road, then one should realize that more shares of a particular security will long-term result in more dividends, more total dollar value, and more return overall than fewer shares would. So if one can accumulate more shares of a security with (admittedly) no additional dollar cost, then why is dividend reinvestment a bad thing?

No... It's still the same exact amount as not having the dividend at all.

How do people still not get that number of shares literally doesn't mean anything? It's the total dollar amount that matters.

avalpert wrote:
More shares at a lower price - same value. So yes, not 'exactly the same' just functionally exactly the same.

You have bought someone else's shares with the dividend (rather than pocketing it or using it for some other purpose). You now own a higher percentage of the company and accordingly more of its future earnings. If the dividend payout per share remains the same, you will get more money next quarter. The person who sold you the shares will get none. How is that functionally equivalent?

No, you would have the same amount of money had the dividend not been issued. You have more shares but it's worth less per share. It's literally the same thing.

Last edited by JustinR on Wed Oct 17, 2018 4:28 pm, edited 2 times in total.